What’s up for 2016?

Forecasting an economic recession

A number of serious indicators of recession in the US and elsewhere in the world have been visibly in play since last fall.

Predictions of an upcoming crisis are seen daily in foreign news sources and online. But how can we know for sure what’s going to happen?

Right now the biggest downturn lies in the financial markets in the US and elsewhere. Stocks have plunged this year. Likewise, long-term US government bonds (e.g., thirty-year treasury bonds) are becoming less popular with buyers too.

The long-term government-bond trend is a good indicator of recession, but the current stock market slump isn’t necessarily so.

When long-term treasury bonds start declining in yield relative to what short-term treasuries pay out it has often meant a recession was coming. That’s because when investors see a recession coming they want to have cash on hand.

For example: say the long-term bond, i.e., a 30 year government bond yield is 1.1 percent and the short-term yield for two-year treasuries is 1 percent. A bond buyer may choose the two-year government bond in hopes that interest rates on thirty-year bonds will be much higher than 1.1 percent at the end of two more years.

In a a recession many investors are more reluctant to tie up money for long periods of time. Their money might earn a lot more interest and dividends sooner if they don’t tie it up. Or they may feel they’ll need more cash to cover unexpected expenses.

However, stocks, unlike long-term bonds, are not necessarily long-term purchases.

In the case of the stock market, the goal is to buy low and sell high—at whatever point buying low or selling high appears to be a good idea to the investor. Some investors will sell at the drop of a dime while others hold, betting the market will pay more for their stock in the future.

Also, in the stock market, the tool of “shorting” via funds such as “the dogs of the Dow,” options, and derivative contracts, enables some investorsto make money who think a stock or several stocks will decline if the dismal future they foresee actually happens.

Shorting can “keep the market honest” or at least indicate a problem in certain companies or markets. But shorting stocks can sometimes also start needless market panics, similar to the stampeding of horses in old Western movies.

Distinguishing between market panics sparked by speculative news articles and opinions that many investors see on the Internet versus a more knowledgeable lack of confidence in the future of the whole stock market by investors who work in the investing business isn’t easy. This is why it’s so difficult to determine whether or not a decline in the stock market is or is not a sign of an upcoming recession.

What’s not difficult to determine is whether or not you should go see the movie The Big Short. This Hollywood movie isn’t just entertainment with a lot of celebrities playing cameo roles in order to explain opaque terms like “synthetic derivatives,” with easy to understand examples—although those cameos are a fun part of it!

The plot line also features several interesting characters whose actions and reactions show the more dangerous parts of what was happening in the run up to the ‘Great Recession’.

Watch the Big Short and you will understand clearly much of what caused the Financial Crisis of 2007-2008 by the time you leave the theater.

You’ll know who won big and who lost big from the roles that big investors, financial institutions, and the US government played as many banks and and some very large corporations crashed and burned.

You may even be able to see the signs of another crisis coming before it arrives. And since you know who suffered last time, you’ll know who probably will suffer again in the face of a quite-possible recession this year.

That’s money well spent, my friends.

p.s. if you can’t see the movie, it’s based on a book with the same name. The book is by Michael Lewis, the author of Liar’s Poker, Moneyball, and The Flash Boys.

Inspiration for this post: US bond yields sound warning on economy by Robin Wigglesworth, London Financial Times January 7, 2016